Tommy Wilkes
LONDON (Reuters) - The coronavirus panic is jolting stock markets, with steep drops in major indexes grabbing the public’s attention. But behind the scenes, there is less understood and potentially more worrying evidence that stress is building to dangerous levels in crucial arteries of the financial system.
Bankers, companies and individual investors are dashing to stock up on cash and other assets considered safe in a downturn to ride out the chaos. This sudden flight to safety is causing havoc in markets for bonds, currency and loans to a degree that hasn’t been seen since the financial crisis of a dozen years ago.
The key concern now, as in 2008, is liquidity: the ready availability of cash and other easily traded financial instruments - and of buyers and sellers who feel secure enough to do deals.
Investors are having trouble buying and selling U.S. Treasuries, considered the safest of all assets. It’s a highly unusual occurrence for one of the world’s most readily tradable financial instruments. Funding in U.S. dollars, the world’s most traded currency, is getting harder to obtain outside the United States.
The cost of funding for money that companies use to make payrolls and other essential short-term needs is rising for weaker-rated firms in the United States. The premium investors pay to buy insurance on junk bonds is increasing. Banks are charging each other more for overnight loans, and companies are drawing down their lines of credit, in case they dry up later.
Taken together, warn some bankers, regulators and investors, these red flags are starting to paint a troubling picture for markets and the global economy: If banks, companies and consumers panic, they can set off a chain of retrenchment that spirals into a bigger funding crunch - and ultimately a deep recession.
Francesco Papadia, who oversaw the European Central Bank’s market operations during the region’s debt crisis a decade ago, said his biggest fear is that the “illiquidity of markets, generated by extreme uncertainty and panic reaction” could “lead to markets freezing, which is an economic life-threatening event.”
“It does not seem to me we are there already, but we could get there quickly,” Papadia said.
A sign of the times is a hashtag now trending on Twitter: #GFC2 - a reference to the possibility of a second global financial crisis.
The warning signals so far are nowhere near as loud as they were in the 2008-2009 financial crisis, or the 2011-2012 euro zone debt crisis, to be sure. And policymakers are acutely aware of the weaknesses in the financial-market plumbing. In recent days, they have ramped up their response.
Central banks have cut interest rates and pumped trillions of dollars of liquidity into the banking system. On Sunday, the U.S. Federal Reserve slashed rates back to near zero, restarted bond buying and joined with other central banks to ensure liquidity in dollar lending to help shore up the economy.
“The one thing central banks know how to do following the experience of 2008 is to prevent a funding crisis from happening,” said Ajay Rajadhyaksha, head of macro research at Barclays Plc and member of a committee that advises the U.S. Treasury on debt management and the economy.
TODAY VS 2008
While the panic sweeping markets is reminiscent of the 2008 financial crisis, comparisons only go so far. Central bankers have last decade’s shocks fresh in their memories. Another key difference: Banks are in better shape today.
In 2008, banks had far less capital and far less liquidity than they have now, said Rodgin Cohen, senior chairman of Wall Street law firm Sullivan & Cromwell LLP and a top advisor to major U.S. financial firms.
Instead, investors and analysts said, the risk this time comes from the pandemic’s impact on the real economy: shuttered shops, travel bans and sections of the labor force sick or quarantined. The freeze means a severe blow for corporate revenues and earnings and overall economic growth, and for now, there is no end in sight.
Countrywide quarantines to block the virus, such as Italy’s, mean “businesses are going to be hit really hard when it comes to receipts, to revenue,” said Stuart Oakley, who oversees forex trading for clients at Nomura Holdings Inc. “However, liabilities are still the same: If you own a restaurant and you borrow money for the rent, you’ve still got to make that monthly payment.”
JPMorgan Chase & Co economists expect first-half contractions in growth across the globe. And this is as the U.S. response to the coronavirus is only getting started.
GRAPHIC: Coronavirus hits financial markets - here
RED FLAGS
Investors and regulators have been alarmed, in particular, by liquidity problems in the $17 trillion U.S. Treasuries market.
There are several signs that something is off. Interest rates, or yields, on Treasuries and other bonds move in inverse relation to their prices: If prices fall, the yields rise. Changes are measured in basis points, or hundredths of a percent.
Typically, yields move a few basis points a day. Now, large and unusually quick swings in yields are making it hard for investors to execute orders. Traders said dealers on Wednesday and Thursday significantly widened the spread in price at which they were willing to buy and sell Treasury bonds - a sign of reduced liquidity.
“The tremors in the Treasury market are the most ominous sign,” said Papadia, the ex-ECB official.
Another alarming signal is the premium non-U.S. borrowers are willing to pay to access dollars, a widely watched gauge of a potential cash crunch. The three-month euro-dollar EURCBS3M=ICAP and dollar-yen JPYCBS3M=ICAP swap spreads surged to their widest since 2017, before dropping on Friday after central banks pumped in more cash.
A measure of the health of the banking system is flashing yellow. The Libor-OIS spread USDL-O0X3=R, which indicates the risk banks are attaching to lending money to one another, has jumped. The spread is now 76 basis points, up from about 13 basis point on Feb. 21, before the coronavirus crunch began in the West. In 2008, it peaked at around 365 basis points.
GRAPHIC: Dollar funding - here
WEAK CORPORATE LINK
As funding markets creak, heavily indebted companies are feeling the heat.
Credit ratings firm Moody’s warns that defaults on lower-rated corporate bonds could spike to 9.7% of outstanding debt in a “pessimistic scenario,” compared with a historical average of 4.1%. The default rate reached 13.4% during the financial crisis.
The cost of insuring against junk debt defaults jumped on Thursday to its highest level in the United States since 2011 and the loftiest in Europe since 2012.
Some companies are now paying more for short-term borrowing. The premium that investors demand to hold riskier commercial paper versus the safer equivalent rose to its highest level this week since March 2009.
Several companies are drawing down on their credit lines with banks or increasing the size of their facilities to ensure they have liquidity when they need it. Bankers said companies fear lenders may not fund agreed credit lines should the market turmoil intensify.
An official at a major central bank said the situation is “pretty bad, as all stars are aligned in a negative way.””Cracks will start to emerge soon,” the official said, “but whether they will develop into something systemic is still hard to say.”
Additional reporting by Sujata Rao and Yoruk Bahceli in London, Tom Westbrook in Singapore and Lawrence Delevingne and Matt Scuffham in New York.; Editing by Paritosh Bansal, Mike Williams and Edward Tobin
A woman a wearing protective face mask, following an outbreak of the coronavirus disease (COVID-19), is reflected in a screen displaying NASDAQ movements outside a brokerage in Tokyo, Japan March 16, 2020. REUTERS/Edgard Garrido
Stocks dive as rescue bids by Fed, peers fail to calm panicky markets
Wayne Cole, Kane Wu
SYDNEY/HONG KONG (Reuters) - Stock markets were routed and the dollar stumbled on Monday after the Federal Reserve slashed interest rates in an emergency move and its major peers offered cheap U.S. dollars to ease a ruinous logjam in global lending markets.
European markets were also poised to open sharply lower, with EUROSTOXX 50 futures down 3.4% and FTSE futures down down 2.7%. E-mini futures for the S&P 500 index hit their downlimit in the first quarter-hour of Asian trade as investors rushed for safety.
The Fed’s emergency 100 basis point cut on Sunday was followed on Monday by the Bank of Japan easing policy further with a pledge to ramp up purchases of exchange-traded funds and other risky assets.
New Zealand’s central bank also shocked by cutting rates 75 basis points to 0.25%, while the Reserve Bank of Australia (RBA) pumped more money into a strained financial system.
Japanese Prime Minister Shinzo Abe said G7 leaders would hold a teleconference at 1400 GMT to discuss the crisis.
The drastic maneuvers were aimed at cushioning the economic impact as the breakneck spread of the coronavirus all but shut down more countries, though they had only limited success in calming panicky investors.
MSCI’s index of Asia-Pacific shares outside Japan tumbled 4% to lows not seen since early 2017, while the Nikkei fell 2% as the Bank of Japan’s easing steps failed to stabilize market confidence.
Data out of China also underscored just how much economic damage the disease had already done to the world’s second-largest economy, with official numbers showing the worst drops in activity on record. Industrial output plunged 13.5% and retail sales 20.5%.
“By any historical standard, the scale and scope of these actions was extraordinary,” said Nathan Sheets, chief economist at PGIM Fixed Income, who helps manage $1.3 trillion in assets. “This is dramatic action and truly does represent a bazooka.”
“Even so, markets were expecting extraordinary action, so it remains to be seen whether the announcement will meaningfully shift market sentiment.”
He emphasized investors wanted to see a lot more U.S. fiscal stimulus put to work and evidence the Trump administration was responding vigorously and effectively to the public health challenges posed by the crisis.
“The performance of the economy and the markets will be mainly determined by the severity and duration of the virus’ outbreak.”
Shanghai blue chips fell 3% even as China’s central bank surprised with a fresh round of liquidity injections into the financial system. Hong Kong’s Hang Seng index tumbled 3.4%.
Australia’s S&P/ASX 200 plunged, finishing down 9.7% for its steepest fall since the 1987 crash.
UNDER STRAIN
Markets have been severely strained as bankers, companies and individual investors stampeded into cash and safe-haven assets, while selling profitable positions to raise money to cover losses in savaged equities.
Such is the dislocation the Fed cut interest rates by 100 basis points on Sunday to a target range of 0% to 0.25%, and promised to expand its balance sheet by at least $700 billion in coming weeks.
Five of its peers also joined up to offer cheap U.S. dollar funding for financial institutions facing stress in credit markets.
U.S. President Donald Trump, who has been haranguing the Fed to ease policy, called the move “terrific” and “very good news.”
“It may be a shot in the arm for risk assets and help to address liquidity concerns...however, it also raises the question of whether the Fed has anything left in the tank should the spread of the virus not be contained,” said Kerry Craig, global market Strategist at J.P. Morgan Asset Management.
“We really need to see the fiscal side...to prevent a longer than needed economic slowdown.”
The Fed’s rate cut combined with the promise of more bond buying pushed U.S. 10-year Treasury yields down sharply to 0.68%, from 0.95% late on Friday.
That pressured the U.S. dollar at first, though it regained some ground as the Asian session wore on. The dollar was last down 1.4% on the Japanese yen at 106.37. The euro was flat at $1.1123.
The commodity-exposed Australian dollar fell 0.3% to $0.6166 while the New Zealand dollar slipped 0.2% to $0.6044.
Oil prices fell on concerns about global demand. Brent crude was last off $1.31 at $32.54 per barrel while U.S. crude slipped 78 cents to $30.94 a barrel.
Gold rallied 0.8% to $1,541.34.
